A DCF, or discounted cash flow, values a company by the cash it will generate in the future, discounted back to what that cash is worth today. Unlike comps, which tell you what the market is paying, a DCF values the business on its own fundamentals. It is the most important valuation method to nail.

What are the four steps of a DCF?

Project unlevered free cash flow, typically for five years, then discount it at WACC. Add a terminal value for everything past the forecast, sum it all to enterprise value, then bridge to equity by subtracting net debt and dividing by diluted shares. Interviewers probe the sequence far more than the arithmetic.

How do you get from enterprise value to equity value in a DCF?

You subtract net debt, which means you subtract debt and add cash. Cash is a non-operating asset the new owner pockets, so it reduces what they effectively pay. Reversing it, adding debt and subtracting cash, inverts the single most-tested relationship in valuation. Then divide by diluted shares for value per share.

DCF

The DCF, explained

By Michael Song · Wharton MBA · ex-Greenhill · investment banking interview coach

4 min read · updated June 29, 2026

A DCF says something simple: a company is worth the cash it will generate in the future, discounted back to what that cash is worth today. It's the most important valuation method to nail. Comps tell you what the market is paying, but the DCF is the only one that values the business on its own fundamentals. It's also where people trip, almost always on sequence, not on math.

Here's the whole pipeline before we break it down:

Project unlevered cash flows, discount them at WACC, sum to enterprise value, then bridge to equity and per-share value.

Step 1: Project unlevered free cash flow

You forecast the cash the business throws off, typically for 5 years. Use unlevered free cash flow, meaning cash before any debt payments:

$\text{UFCF} = \text{EBIT}\times(1-t) + \text{D\&A} - \Delta\text{NWC} - \text{CapEx}$

Start from EBIT (operating profit, before interest), tax it, add back non-cash D&A, then subtract the real cash drains: investment in working capital and capital expenditures.

Common mistake

Using levered free cash flow (cash after interest) and then discounting at WACC. Pick a lane. Unlevered FCF discounts at WACC (it belongs to all capital providers). Levered FCF discounts at cost of equity (it belongs to equity holders only). Mixing them is the most common DCF error there is.

Step 2: Discount at WACC

Future cash is worth less than cash today, so you discount it. The rate is the weighted average cost of capital, the blended return debt and equity holders require:

$\text{WACC} = \frac{E}{V}\,r_e + \frac{D}{V}\,r_d\,(1-t)$

Cost of equity ( $r_e$ ) comes from CAPM (risk-free rate + beta × equity risk premium). The debt term is after-tax because interest is tax-deductible. WACC is the discount rate for unlevered cash flows.

Step 3: Terminal value

You can't forecast forever, so after the explicit years you capture everything beyond with a terminal value, two ways:

Gordon growth (perpetuity): $\; TV = \dfrac{FCF_{n}\times(1+g)}{r - g}\;$ grows the final-year cash flow at a modest perpetual rate $g$ (think long-run GDP, roughly 2% to 3%) and capitalizes it.
Exit multiple: apply a market multiple (e.g. EV/EBITDA) to the final-year metric.

Common mistake

People reach for terminal value before they have a discount rate. You need WACC first. Gordon growth literally has $r$ in the denominator, and the terminal value still has to be discounted back to today like every other cash flow. Sequence: build FCF → solve WACC → then terminal value.

Step 4: Sum to enterprise value, then bridge to equity

Discount every year's FCF and the terminal value back to today and add them up. That sum is enterprise value, the value of the operating business, independent of how it's financed.

But investors own equity, so you bridge across:

Enterprise value is what the business is worth; subtract net debt to get to equity value.

$\text{Equity Value} = \text{Enterprise Value} - \text{Debt} + \text{Cash}$

Common mistake

The bridge trips up more candidates than anything else: going from enterprise to equity value you subtract net debt, which means cash is ADDED and debt is subtracted. Cash is a non-operating asset the new owner pockets, so it reduces what they effectively pay. Reverse it (adding debt, subtracting cash) and you've inverted the single most-tested relationship in valuation.

Divide equity value by diluted shares and you have value per share.

A 30-second version

Say a business throws off $100 of unlevered FCF next year, growing 2% forever, at a 10% WACC. Perpetuity value ≈ $100 \times 1.02 / (0.10 - 0.02) =$ $1,275 of enterprise value. Net debt of $275? Equity value $1,000. Clean round numbers, exactly how you'd do it without a calculator.

Interview tip

Be able to say the four steps in order without thinking: project unlevered FCF → discount at WACC → add terminal value → bridge enterprise to equity. Interviewers probe the sequence and the why unlevered/why WACC logic far more than your arithmetic. That structural fluency is what reads as "this person has actually built one."

Glossary

New to the lingo? Every term used above, in plain English.

DCF (Discounted Cash Flow): A way to value a company by projecting its future cash and discounting it back to what it is worth in today’s dollars.
Trading comps: Comparable companies analysis. You value a company by looking at the multiples that similar public companies trade at right now.
Unlevered free cash flow: The cash a business generates before any debt payments, so it belongs to all investors, both lenders and shareholders. This is the cash flow used in a DCF.
EBIT (Earnings Before Interest and Taxes): A company operating profit before interest and taxes are taken out. It measures how much the core business earns regardless of how it is financed.
D&A (Depreciation and Amortization): Spreading the cost of long-lived assets over the years they are used. Depreciation is for physical assets, amortization for intangible ones. Both are non-cash expenses.
Net working capital (NWC): The short-term money tied up in running the business, roughly current assets like inventory and receivables minus current liabilities like payables. Growth in it uses up cash.
CapEx (Capital Expenditures): Cash a company spends to buy or upgrade long-lived assets like equipment, factories, or technology. It is an investment in the business, not a day-to-day expense.
WACC (Weighted Average Cost of Capital): The blended rate a company pays to fund itself with both debt and equity. In a DCF it is the discount rate used to bring future cash back to today.
Terminal Value: In a DCF, the estimated value of all the cash flows that come after the years you forecast explicitly. It often makes up most of the total value.
Exit multiple: A valuation shortcut for terminal value that applies a market multiple, such as EV/EBITDA, to the final forecast year to estimate what the business would sell for at the end.
EV (Enterprise Value): The value of a company’s whole operations, to every investor including lenders and shareholders. It does not depend on how the company is financed.
Net debt: A company total debt minus its cash. It is what you subtract from enterprise value to get to equity value, since a buyer could use the cash to pay down the debt.
Equity Value: The slice of a company that belongs to its shareholders. For a public company this is the market capitalization (share price times shares outstanding).

Frequently asked

What is a DCF?: A DCF, or discounted cash flow, values a company by the cash it will generate in the future, discounted back to what that cash is worth today. Unlike comps, which tell you what the market is paying, a DCF values the business on its own fundamentals. It is the most important valuation method to nail.
What are the four steps of a DCF?: Project unlevered free cash flow, typically for five years, then discount it at WACC. Add a terminal value for everything past the forecast, sum it all to enterprise value, then bridge to equity by subtracting net debt and dividing by diluted shares. Interviewers probe the sequence far more than the arithmetic.
How do you get from enterprise value to equity value in a DCF?: You subtract net debt, which means you subtract debt and add cash. Cash is a non-operating asset the new owner pockets, so it reduces what they effectively pay. Reversing it, adding debt and subtracting cash, inverts the single most-tested relationship in valuation. Then divide by diluted shares for value per share.

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